USco, a domestic corporation, produces industrial engines at its United States plant for sale in the United States and Canada. USco also has a plant in Canada that performs the final stages of production with respect to the engines sold in Canada. All of the output of the Canadian plant is sold in Canada, whereas only 25% of the output of the United States plant is shipped to Canada. The other 75% of the output of the U.S. plant is sold to customers in the United States. The Canadian operation is classified as a branch for United States tax purposes. During the current year, UScos total sales to Canadian customers were $12 million, and the related cost of goods sold is $9 million. The average value of production assets is $30 million at the U.S. plant and $5 million at the Canadian plant.

How much of UScos gross profit of $3 million on sales to Canadian customers (export sales of $12 million less $9 million cost of goods sold) is classified as a foreign source for U.S. tax purposes?

Now assume that the facts are the same as in part (a), except that the Canadian factory is structured as a wholly-owned Canadian subsidiary, rather than a branch. UScos sales of semi-finished engines to the Canadian subsidiary (which still represent 25% of its output) were $6 million during the year, and the related cost of goods sold was $4 million. The Canadian subsidiarys total sales of finished engines to Canadian customers (which represents all of its output) was $12 million, and the related cost of goods sold is $9 million. The average value of production assets is still $30 million at the U.S. plant, and $5 million at the Canadian plant, and USco sells all goods with title passing at its U.S. plant. How much of UScos gross profit of $2 million on sales to the Canadian subsidiary is classified as a foreign source for U.S. tax purposes?